May 23, 2012

“Fannie & Freddie Were Trying To Keep Up With Wall Street”

May 23, 2012

“Fannie & Freddie Were Trying To Keep Up With Wall Street”

The GSE’s have gone through, and are undergoing, a tremendous “brain drain” as management and seasoned personnel leaving (of course, many talented people remain). But there is some thinking out in the industry that “we’ll get what we pay for” going forward. And say what you will about the industry needing the agencies (and I am a proponent of them in many roles), the uncertainty about Freddie & Fannie’s future is impacting the business – but there will be no resolution until 2013, after the election.

There is no question that Fannie & Freddie set standards in documentation & underwriting, add to liquidity, and give investors stability. Elizabeth Duke, a governor at the Federal Reserve, said the unresolved status of Fannie Mae and Freddie Mac is hurting the housing recovery. “Uncertainty about the future on the part of lenders is inhibiting these investments” in mortgage lending. She also noted that uncertainty over regulations and the outlook for home prices is hindering mortgage lending. This is not a surprise to anyone in the business.

Along those lines, looking back at the agency role 10 years ago, I received this e-mail

“Fannie and Freddie were trying to keep up with Wall Street. Investment banks made the market, created demand (because they had gobs of cash to invest that needed a home), and ended up taking FNMA /FHMC market share simply by expanding the market size with this product. Granted, the Agencies aren’t innocent, but Wall Street built the infrastructure, and it was Wall Street who marketed it – they had a huge liquidity appetite to feed. The GSE’s had to follow to maintain share, and because they had to get approval from Congress, they stupidly cloaked their strategy in “Affordable Housing for all” – who wouldn’t vote for that? – especially when Congress was not presented with the real risk picture.”

The note continues:

“I would say that the traditional depository banks such as Chase and Wells and BofA had to try to follow the Street as well. But it was the Wall Street Investment and trading Banks that created the securities and sales infrastructure, product, and demand. Once the product guidelines were released into the secondary market, it became much cheaper and frictionless to do that product, and have the borrower pay just a little more…..and oh by the way – the Street was paying the originator way up for that product as well, comparable to Fannie & Freddie – especially right at the end, when the Street was desperate for high credit quality product to fluff their securities prospectuses. I do remember specifically a day that my client called me and told me that the Street was bidding up for regular Agency product – not the affordable subprime stuff – and it was more than FNMA/ FHLMC was paying. I sensed there was something fishy at the time, but I had no idea. That was February 2007, 3 months before the first “no bid” because there was no market for a Subprime pool in May. It’s convenient for certain political leaning groups to blame the Agencies (government), just like it’s convenient for other political leaning groups to blame the banks. Both are wrong, and both are right.”

And a mortgage bank owner from Oregon wrote:

“In reality it was the indirect effects of Fannie and Freddie policy goals that greatly influenced some of the worst decisions the banks and investment companies made. One example was that by 2002 the GSEs mandated a goal of 50% of all home loans made by lenders had to be made to low and subprime borrows. These are loans that in the best of times would have made up approx. 15% of the loan pool. So to stay compliant lenders especially banks were making loans they did not want on their books thus the tremendous expansion of securitization, CDO’s.”

And now the agencies, and investors in mortgage-backed securities, are grappling with the prospect of principal reductions. Edward DeMarco, the temporary director of the Federal Housing Finance Agency, continues to endure blistering criticism for refusing to allow Fannie and Freddie to pay for large-scale principal reductions for underwater borrowers or to facilitate refinancings for those stuck with high interest rate mortgages.